Economics, public policy, monetary policy, financial regulation, with a New Zealand perspective

The Shadow Board on the OCR

Some months ago I wrote about the NZIER’s Shadow Board, a panel of expert and informed observers who are each asked prior to each OCR review to provide a probability distribution as to what OCR is “appropriate for the economy”. It isn’t quite the same job as the Reserve Bank has – the Bank has to follow the PTA, and in principle the panel members might, say, agree with the two NZIER economists who recently argued for nominal GDP targeting.

There isn’t usually much information in the results of the Shadow Board exercise. They usually track remarkably closely with the Governor’s own choice about the OCR, so they are right or wrong about as often as the Governor is.

That pattern continues this month. The mean expectation across the respondents has dropped a little, from 2.70 per cent in October to 2.67 per cent this time. Whichever way the Governor goes tomorrow the Shadow Board will have been close.

I’ve been more struck by the lack of much diversity in the views (across panel members) and the high degree of confidence with which each panel members appears to hold his view. This time the lower quartile expectation is 2.5 per cent and the upper quartile is 2.75 per cent. According to these respondents there is only a 12 per cent chance that something other than 2.5 or 2.75 is the right OCR for the economy.

I don’t really understand how anyone can be that certain, given the uncertainties about the current state of the economy, the future, and about the connections between real activity and inflation (or other nominal variables monetary policy can target).

I told an interviewer this morning that I thought the economy would be better off with the OCR at 1.75 per cent than at 2.75 per cent. I hadn’t distributed my probabilities then, but I’ve put them in the chart below (and compared them to those of the Shadow Board). My numbers effectively say that I think there is roughly a 30 per cent chance that the consensus view is correct.

It would be interesting to know the probabilities the Governor and his chief advisers would assign. We’ll know the mean tomorrow, but almost certainly will learn little or nothing about the distribution. Having information of that sort – whether as a table like the Shadow Board provides, or as fan charts – would provide useful information on how these senior officials think about the economy.

They seem to answer a different question, something like “Assign a probability for the NEXT OCR move?” Their answer is obvious, up 25 basis point, down 25, and no change. That is why they are close because the Bank does that all the time. The Bank rarely goes down 100 basis points or up 100. You on the other hand answer the question “what the OCR SHOULD BE?” It seems that you are answering different questions.

Rarely? 25 basis points 4 times within 12 months is 100 basis points? We saw that recently with Wheeler? What people do not understand is that 100 basis points is equivalent to interest costs rising by 40% in a ver short space of time. For businesses that rely entirely on debt, like the building industry it is a disaster.

Going down, the retail banks do not always pass on the reduction so it might be 24 to 36 months before you get the full impact of the 100 basis point reduction but going up the increases are passed on immediately and you get the impact in 12 months.

I do enjoy reading your blog (anytime), but it is even better after a few craft beers. But I must resist commenting in any serious way at the moment. hic. Having said that, if the “shadow board” members can’t answer a simple question it seems like we need to get a new “shadow board”. Would it be embarrassing to be booted off the “shadow board”? How would one put that on ones CV?